Complete Quantitative Investment Analysis, 4th Edition Cfa Institute PDF For All Chapters
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Preface xv
Acknowledgments xvii
CHAPTER 1
The Time Value of Money 1
Learning Outcomes 1
1. Introduction 1
2. Interest Rates: Interpretation 2
3. The Future Value of a Single Cash Flow 4
3.1. The Frequency of Compounding 9
3.2. Continuous Compounding 11
3.3. Stated and Effective Rates 12
4. The Future Value of a Series of Cash Flows 13
4.1. Equal Cash Flows—Ordinary Annuity 14
4.2. Unequal Cash Flows 15
5. The Present Value of a Single Cash Flow 16
5.1. Finding the Present Value of a Single Cash Flow 16
5.2. The Frequency of Compounding 18
6. The Present Value of a Series of Cash Flows 20
6.1. The Present Value of a Series of Equal Cash Flows 20
6.2. The Present Value of an Infinite Series of Equal Cash Flows—Perpetuity 24
6.3. Present Values Indexed at Times Other than t = 0 25
6.4. The Present Value of a Series of Unequal Cash Flows 27
7. Solving for Rates, Number of Periods, or Size of Annuity Payments 27
7.1. Solving for Interest Rates and Growth Rates 28
7.2. Solving for the Number of Periods 30
7.3. Solving for the Size of Annuity Payments 31
7.4. Review of Present and Future Value Equivalence 35
7.5. The Cash Flow Additivity Principle 37
8. Summary 38
Practice Problems 39
v
vi Contents
CHAPTER 2
Organizing, Visualizing, and Describing Data 45
Learning Outcomes 45
1. Introduction 45
2. Data Types 46
2.1. Numerical versus Categorical Data 46
2.2. Cross-Sectional versus Time-Series versus Panel Data 49
2.3. Structured versus Unstructured Data 50
3. Data Summarization 54
3.1. Organizing Data for Quantitative Analysis 54
3.2. Summarizing Data Using Frequency Distributions 57
3.3. Summarizing Data Using a Contingency Table 63
4. Data Visualization 68
4.1. Histogram and Frequency Polygon 68
4.2. Bar Chart 69
4.3. Tree-Map 73
4.4. Word Cloud 73
4.5. Line Chart 75
4.6. Scatter Plot 77
4.7. Heat Map 81
4.8. Guide to Selecting among Visualization Types 82
5. Measures of Central Tendency 85
5.1. The Arithmetic Mean 85
5.2. The Median 90
5.3. The Mode 92
5.4. Other Concepts of Mean 92
6. Other Measures of Location: Quantiles 102
6.1. Quartiles, Quintiles, Deciles, and Percentiles 103
6.2. Quantiles in Investment Practice 108
7. Measures of Dispersion 109
7.1. The Range 109
7.2. The Mean Absolute Deviation 109
7.3. Sample Variance and Sample Standard Deviation 111
7.4. Target Downside Deviation 114
7.5. Coefficient of Variation 117
8. The Shape of the Distributions: Skewness 119
9. The Shape of the Distributions: Kurtosis 121
10. Correlation between Two Variables 125
10.1. Properties of Correlation 126
10.2. Limitations of Correlation Analysis 129
11. Summary 132
Practice Problems 135
Contents vii
CHAPTER 3
Probability Concepts 147
Learning Outcomes 147
1. Introduction 148
2. Probability, Expected Value, and Variance 148
3. Portfolio Expected Return and Variance of Return 171
4. Topics in Probability 180
4.1. Bayes’ Formula 180
4.2. Principles of Counting 184
5. Summary 188
References 190
Practice Problem 190
CHAPTER 4
Common Probability Distributions 195
Learning Outcomes 195
1. Introduction to Common Probability Distributions 196
2. Discrete Random Variables 196
2.1. The Discrete Uniform Distribution 198
2.2. The Binomial Distribution 200
3. Continuous Random Variables 210
3.1. Continuous Uniform Distribution 210
3.2. The Normal Distribution 214
3.3. Applications of the Normal Distribution 220
3.4. The Lognormal Distribution 222
4. Introduction to Monte Carlo Simulation 228
5. Summary 231
References 233
Practice Problems 234
CHAPTER 5
Sampling and Estimation 241
Learning Outcomes 241
1. Introduction 242
2. Sampling 242
2.1. Simple Random Sampling 242
2.2. Stratified Random Sampling 244
2.3. Time-Series and Cross-Sectional Data 245
3. Distribution of the Sample Mean 248
3.1. The Central Limit Theorem 248
4. Point and Interval Estimates of the Population Mean 251
4.1. Point Estimators 252
4.2. Confidence Intervals for the Population Mean 253
4.3. Selection of Sample Size 259
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viii Contents
CHAPTER 6
Hypothesis Testing 275
Learning Outcomes 275
1. Introduction 276
2. Hypothesis Testing 277
3. Hypothesis Tests Concerning the Mean 287
3.1. Tests Concerning a Single Mean 287
3.2. Tests Concerning Differences between Means 294
3.3. Tests Concerning Mean Differences 299
4. Hypothesis Tests Concerning Variance and Correlation 303
4.1. Tests Concerning a Single Variance 303
4.2. Tests Concerning the Equality (Inequality) of Two Variances 305
4.3. Tests Concerning Correlation 308
5. Other Issues: Nonparametric Inference 310
5.1. Nonparametric Tests Concerning Correlation: The Spearman
Rank Correlation Coefficient 312
5.2. Nonparametric Inference: Summary 313
6. Summary 314
References 317
Practice Problems 317
CHAPTER 7
Introduction to Linear Regression 327
Learning Outcomes 327
1. Introduction 328
2. Linear Regression 328
2.1. Linear Regression with One Independent Variable 328
3. Assumptions of the Linear Regression Model 332
4. The Standard Error of Estimate 335
5. The Coefficient of Determination 337
6. Hypothesis Testing 339
7. Analysis of Variance in a Regression with One Independent Variable 347
8. Prediction Intervals 350
9. Summary 353
References 354
Practice Problems 354
Contents ix
CHAPTER 8
Multiple Regression 365
Learning Outcomes 365
1. Introduction 366
2. Multiple Linear Regression 366
2.1. Assumptions of the Multiple Linear Regression Model 372
2.2. Predicting the Dependent Variable in a Multiple
Regression Model 376
2.3. Testing Whether All Population Regression Coefficients
Equal Zero 378
2.4. Adjusted R2 380
3. Using Dummy Variables in Regressions 381
3.1. Defining a Dummy Variable 381
3.2. Visualizing and Interpreting Dummy Variables 382
3.3. Testing for Statistical Significance 384
4. Violations of Regression Assumptions 387
4.1. Heteroskedasticity 388
4.2. Serial Correlation 394
4.3. Multicollinearity 398
4.4. Heteroskedasticity, Serial Correlation, Multicollinearity:
Summarizing the Issues 401
5. Model Specification and Errors in Specification 401
5.1. Principles of Model Specification 402
5.2. Misspecified Functional Form 402
5.3. Time-Series Misspecification (Independent Variables
Correlated with Errors) 410
5.4. Other Types of Time-Series Misspecification 414
6. Models with Qualitative Dependent Variables 414
6.1. Models with Qualitative Dependent Variables 414
7. Summary 422
References 425
Practice Problems 426
CHAPTER 9
Time-Series Analysis 451
Learning Outcomes 451
1. Introduction to Time-Series Analysis 452
2. Challenges of Working with Time Series 454
3. Trend Models 454
3.1. Linear Trend Models 455
3.2. Log-Linear Trend Models 458
3.3. Trend Models and Testing for Correlated Errors 463
4. Autoregressive (AR) Time-Series Models 464
4.1. Covariance-Stationary Series 465
4.2. Detecting Serially Correlated Errors in an Autoregressive Model 466
x Contents
CHAPTER 10
Machine Learning 527
Learning Outcomes 527
1. Introduction 527
2. Machine Learning and Investment Management 528
3. What is Machine Learning? 529
3.1. Defining Machine Learning 529
3.2. Supervised Learning 529
3.3. Unsupervised Learning 531
3.4. Deep Learning and Reinforcement Learning 531
3.5. Summary of ML Algorithms and How to Choose among Them 532
4. Overview of Evaluating ML Algorithm Performance 533
4.1. Generalization and Overfitting 534
4.2. Errors and Overfitting 534
4.3. Preventing Overfitting in Supervised Machine Learning 537
5. Supervised Machine Learning Algorithms 539
5.1. Penalized Regression 539
5.2. Support Vector Machine 541
5.3. K-Nearest Neighbor 542
5.4. Classification and Regression Tree 544
5.5. Ensemble Learning and Random Forest 547
6. Unsupervised Machine Learning Algorithms 559
6.1. Principal Components Analysis 560
6.2. Clustering 563
7. Neural Networks, Deep Learning Nets, and Reinforcement Learning 575
7.1. Neural Networks 575
Contents xi
CHAPTER 11
Big Data Projects 597
Learning Outcomes 597
1. Introduction 597
2. Big Data in Investment Management 598
3. Steps in Executing a Data Analysis Project: Financial Forecasting
with Big Data 599
4. Data Preparation and Wrangling 603
4.1. Structured Data 604
4.2. Unstructured (Text) Data 610
5. Data Exploration Objectives and Methods 617
5.1. Structured Data 618
5.2. Unstructured Data: Text Exploration 622
6. Model Training 629
6.1. Structured and Unstructured Data 630
7. Financial Forecasting Project: Classifying and Predicting
Sentiment for Stocks 639
7.1. Text Curation, Preparation, and Wrangling 640
7.2. Data Exploration 644
7.3. Model Training 654
7.4. Results and Interpretation 658
8. Summary 664
Practice Problems 665
CHAPTER 12
Using Multifactor Models 675
Learning Outcomes 675
1. Introduction 675
2. Multifactor Models and Modern Portfolio Theory 676
3. Arbitrage Pricing Theory 677
4. Multifactor Models: Types 683
4.1. Factors and Types of Multifactor Models 683
4.2. The Structure of Macroeconomic Factor Models 684
4.3. The Structure of Fundamental Factor Models 687
4.4. Fixed-Income Multifactor Models 691
5. Multifactor Models: Selected Applications 695
5.1. Factor Models in Return Attribution 696
5.2. Factor Models in Risk Attribution 698
xii Contents
CHAPTER 13
Measuring and Managing Market Risk 713
Learning Outcomes 713
1. Introduction 714
2. Understanding Value at Risk 714
2.1. Value at Risk: Formal Definition 715
2.2. Estimating VaR 718
2.3. Advantages and Limitations of VaR 730
2.4. Extensions of VaR 733
3. Other Key Risk Measures—Sensitivity and Scenario Measures 735
3.1. Sensitivity Risk Measures 736
3.2. Scenario Risk Measures 740
3.3. Sensitivity and Scenario Risk Measures and VaR 746
4. Using Constraints in Market Risk Management 750
4.1. Risk Budgeting 751
4.2. Position Limits 752
4.3. Scenario Limits 752
4.4. Stop-Loss Limits 753
4.5. Risk Measures and Capital Allocation 753
5. Applications of Risk Measures 755
5.1. Market Participants and the Different Risk Measures They Use 755
6. Summary 764
References 766
Practice Problems 766
CHAPTER 14
Backtesting and Simulation 775
Learning Outcomes 775
1. Introduction 775
2. The Objectives of Backtesting 776
3. The Backtesting Process 776
3.1. Strategy Design 777
3.2. Rolling Window Backtesting 778
3.3. Key Parameters in Backtesting 779
3.4. Long/Short Hedged Portfolio Approach 781
3.5. Pearson and Spearman Rank IC 785
3.6. Univariate Regression 789
3.7. Do Different Backtesting Methodologies Tell the Same Story? 789
Contents xiii
Appendices 855
Glossary 865
Index 887
PREFACE
We are pleased to bring you Quantitative Investment Analysis, Fourth Edition, which focuses
on key tools that are needed for today’s professional investor. In addition to classic areas
such as the time value of money and probability and statistics, the text covers advanced con-
cepts in regression, time series, machine learning, and big data projects. The text teaches
critical skills that challenge many professionals, and shows how these techniques can be
applied to areas such as factor modeling, risk management, and backtesting and simulation.
The content was developed in partnership by a team of distinguished academics and
practitioners, chosen for their acknowledged expertise in the field, and guided by CFA
Institute. It is written specifically with the investment practitioner in mind and is replete
with examples and practice problems that reinforce the learning outcomes and demonstrate
real-world applicability.
The CFA Program Curriculum, from which the content of this book was drawn, is sub-
jected to a rigorous review process to assure that it is:
• Faithful to the findings of our ongoing industry practice analysis
• Valuable to members, employers, and investors
• Globally relevant
• Generalist (as opposed to specialist) in nature
• Replete with sufficient examples and practice opportunities
• Pedagogically sound
The accompanying workbook is a useful reference that provides Learning Outcome
Statements that describe exactly what readers will learn and be able to demonstrate after
mastering the accompanying material. Additionally, the workbook has summary overviews
and practice problems for each chapter.
We are confident that you will find this and other books in the CFA Institute
Investment Series helpful in your efforts to grow your investment knowledge, whether you
are a relatively new entrant or an experienced veteran striving to keep up to date in the
ever-changing market environment. CFA Institute, as a long-term committed participant
in the investment profession and a not-for-profit global membership association, is pleased
to provide you with this opportunity.
xv
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ACKNOWLEDGMENTS
Special thanks to all the reviewers, advisors, and question writers who helped to ensure high
practical relevance, technical correctness, and understandability of the material presented
here.
We would like to thank the many others who played a role in the conception and pro-
duction of this book: the Curriculum and Learning Experience team at CFA Institute, with
special thanks to the curriculum directors, past and present, who worked with the authors
and reviewers to produce the chapters in this book; the Practice Analysis team at CFA
Institute; and the Publishing and Technology team for bringing this book to production.
xvii
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también suyo. Véase O. Müller, De P. Annio Floro poeta et carmine
quod Pervigilium Veneris inscriptum est, Berlín, 1855.
Por eso creo yo que hay que ahondar en las raíces germánicas, indo-
europeas y vascongadas á la vez, deslindando los entronques de
cada voz, juntando todas las voces emparentadas en todas estas
lenguas para ver de dónde salió la voz dudosa. Tal he procurado
hacer en el Tesoro de la lengua castellana, donde el lector podrá ver
lo que atañe á las voces citadas y las demás. Más de la mitad del
Diccionario románico está en este caso. No basta inventar la forma
latina ó poner la correspondiente del bajo latín, pues de ella no
nacieron las románicas, sino al revés. ¿Qué sacamos con poner por
fórmula brīsa, bosca, brocus? Esas voces no se han dicho jamás; son
fórmulas latinizadas de otras voces vivas. Lo que se busca no son
fórmulas, sino el origen de esas voces. Como, por otra parte, hay
radicales latinos, germánicos y éuscaros parecidos, ya que tienen un
mismo origen, según los gustos y preferencias, así señalan como
origen de las voces románicas, éste la raíz latina, aquél la
germánica, nadie la éuscara, porque el éuscaro lo desconocen. El
estudio comparado de los tres radicales, latino, germánico y éuscaro,
y de los derivados, esto es, de todo el parentesco, sería el único
medio de averiguar la verdad, como hago yo en el Tesoro. Después
de haberse estudiado á fondo la lexicografía latina y germana,
todavía queda á oscuras la mitad del Diccionario románico. Luego,
además del latín y del germano, alguna otra fuente del romanismo
queda por descubrir. No es la arábiga ni la céltica: todos convienen
en ello. ¿Cuál será? ¿De dónde vendrá la luz á la lexicografía
románica, tan oscura aun después de bien conocidas las lenguas que
pudieran haber originado el caudal de sus voces? Extraño parece
que quedando un idioma ahí, en medio de las románicas, como un
antiquísimo islote, nadie se ponga á estudiarlo, y cuando alguien lo
hace, es con tan mala mano ó dañada intención, que por no conocer
la cepa éuscara entera, córtale un sarmiento, diciendo ser de la cepa
latina que tiene al lado. Hay, en efecto, quien se entretiene en
probar que ésta y la otra voz vascongada es latina de origen, y va
desmochando de manera el idioma vasco, que, á este paso, se
queda sin diccionario, con tener la gramática más complicada y
maravillosa del mundo: tal hace Schuchardt. Razones aparentes no
le faltan al dar por latinas las voces realmente éuscaras, porque,
teniendo un mismo origen los radicales éuscaros y los latinos, el
parecido no puede faltar. Y claro está, todo le parece hablar en favor
del latín, pues se habló en España, donde halla esas voces
explicables por el latín. Como si en España no se hubiera hablado
más generalmente el éuscaro y por más siglos y mucho antes de
llegar á ella el latín. El estudio de la lexicografía vasca, desde sus
raíces y en todos sus derivados, y en cotejo con la lexicografía latina,
es indispensable para decidir si tal ó cual voz es latina ó vasca en su
origen. Ese estudio no lo ha hecho el citado desmochador, ese
estudio es el que he llevado al cabo en el Tesoro de la lengua
castellana, que vuelvo á mentar, porque los romanistas, por falta de
conocimiento del éuscaro, todavía no lo han tenido en cuenta, y creo
hay que tenerlo, aunque me esté á mí mal el decirlo. Volvamos al
germanismo. Las terminaciones nominales, iguales en las
germánicas y en latín, aumentan la dificultad de distinguir los
vocablos que vienen de aquellas lenguas ó de ésta. Tan románicas
como germánicas son las terminaciones -o, masc., y -a, fem., como
en kuppo, kampo, brando, elmo, blanco, mariscalco, bruno, falbo, y
en duna, falta, marca. Igualmente es germánica y latina la
terminación -ón, como en espolón, campeón, escorpión. Los verbos
germánicos en i (de -ian) responden á los latinos en -i (de -ire),
como furbire, ital., y furbian, germ.; guarnir y warnian, tarir, fr., y
tharrian, honnir y hōnian = haunian. Con todo, pueden servir de
notas distintivas algunas particularidades, pero aun con ellas no se
aclaran del todo las dificultades. Las románicas ponen gu donde las
germánicas llevaban w: guarir y warian, guarnir y warnian. La h
germánica se conserva en francés, y la h latina se pierde en todas
las románicas, it. elmo, cast., yelmo; pero fr. heaume del germ.
helm. Los grupos hr y hn se hacen har, han: fr. hanap, de hnapp;
harangue y arenque, de hring. El acento germánico, que va en la
sílaba radical, no pasa á las románicas, y así se atienen ellas, por
analogía, á la acentuación latina que éstas conservan.
Durante los siglos iii y iv hubo casi continuas guerras entre los godos
y los romanos, en las riberas del Danubio, hasta que el 402 entró en
Italia, con sus visigodos, el rey Alarico, del antiguo linaje de los
Balthos. El 406 entran los ostrogodos con Radagaso. Vuelve Alarico á
Italia el 408 y se apodera el 410 de Roma. Muerto á poco, siguen los
godos en Italia, con su cuñado Ataulfo, hasta el 412, que pasa con
ellos al Sur de Francia, conquista la Aquitania y funda el reino de
Tolosa el año 418, entrando en España, por donde extiende sus
dominios. Ataulfo es para nosotros el primer rey godo.
Á principios del siglo xix publicó Raynouard una serie de obras, cuya
reseña puede verse en la Poesie der Troubadours, de Diez (1827),
compuso la Gramática y el Diccionario de la lengua de los Trovadores
provenzales, y tomó el empeño de probar que todas las lenguas
románicas procedían de esa lengua, la única derivada
inmediatamente del latín. Admitieron esta teoría Perticari,
Champollion-Figéac, Sismondi, Niccolini, Lampredi, Ugo Fóscolo,
Balbi y Bernhardy; la desecharon Daunou, Galvani y Schlegel sobre
todo (Observations sur la Langue et la Littérature Provençales, París,
1818). La tesis hizo mucho ruido entre los literatos y fué impugnada
por George Cornewal Lewis, en su Essay on the origin and formation
of the Romance Languages, Oxford, 1835. La Grammatik der
Romanischen Sprachen, de Diez, publicada en Bonn, de 1836 á
1844, y luego su Etymologisches Wörterbuch der Rom. Sprachen
(Bonn, 1853), pusieron en olvido tan extravagante teoría, sin
atacarla directamente, con la sola exposición amplia y científica de
las lenguas románicas, que en estas obras hizo el fundador del
romanismo.
Las obras de Tajón en la Esp. Sagr., t. XXXI; Bonilla, Hist. filos. esp.,
t. I, pág. 257, y Z. García Villada, Fragmentos inéditos de Tajón
(Revista de Archivos, enero-febrero de 1914). Las obras de San
Julián en Migne, Patr., XCVI. Pero juntos los Padres toledanos, en la
edición de Lorenzana: SS. Patrum Toletanorum Opera; Madrid, 1782.
Véase, además, el P. Tailhan, Les bibliothèques espagnoles du Haut
Μoyen Age; París, 1877.